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Saturday, May 4, 2013

Stocks for the Long Run

After the release of the encouraging jobs report yesterday morning, the stock market promptly hit new record highs. Now what?

Well, as you know by now, my long held view is that we're going higher, in fact a lot higher, the next few years. From 15,000 yesterday, Dow 20,000 and then 30,000 by 2020 and 2030 look like quite reasonable targets to me. And we'll be getting nice cash dividends all along the way.

And here are four reasons why I'm so optimistic about our future in this current world of gloom and doom.

(1) The North American energy revolution is real, and solid and increasingly strong private sector growth led by housing and a resurgence of American based manufacturing will help energy lead the way. Companies are in excellent shape financially, and stock market values are not overpriced at present levels.

(2) Our dysfunctional government knows best gang won't be nearly as big a negative factor on economic growth the next several years (with such low expectations in place now, they could even surprise us on the upside). The sequester, arbitrary as it is, has revealed to We the People the enormous amounts of waste in our system which the President and the rest of the government officials have chosen to ignore for far too long now. The post office financial mess and government financed "Solyndra type investments" are helping inform the public, too. The fact is that government and its OPM ways can't be trusted with any more MOM than is absolutely necessary to provide the basic services we're willing to pay for in full.

(3) Throw in the public sector's pension affordability and funding issues in numerous cities and states, and the sustainability of our federal Social Security and Medicare programs, along with the introduction of ObamaCare (a mess in the making), and We the People are becoming familiar with the financial issues we're facing and which the government can't solve. Awareness always leads to solutions, so that's a good start.

(4) And speaking of awareness, we know that we need to get serious about creating AT LEAST another 10 million good jobs and improving our system and cost of government run education as well, from K-12 through college. And that our young people can't find good jobs, even after attending and graduating from college with a boatload of student loans to repay.

So all in all, we have lots of issues but none that can't and won't be brought under control. We're going down a rocky road, but it's the right road. We'll learn more about its many benefits as we go.

"Conventional wisdom tells you that stock returns are tied to the fortunes of the broader economy. If factories are humming, unemployment is low and people are spending money, stocks should move higher.

But talk to enough people on Wall Street, and you’ll be reminded again and again that economic growth does not equal stock-market returns. This is something we know intuitively. Over the past four years, for instance, economic growth has been anything but robust. But there goes the Dow, surging 125% in the past four years.

Now, here comes a corrective to the corrective. In a report slated for release today, partners at McKinsey & Co., the management consulting firm, which occasionally puts out think pieces, argues that much of the U.S. stock market’s performance over the past half-century “is clearly linked to the performance of the real economy.”

Their prediction: that if the U.S. can average real GDP growth of 2-3% each year and inflation doesn’t run rampant, you can expect between 5% and 7% stock returns over the next few decades. In fact, the McKinsey folks say they can’t foresee stock returns falling below an average of 5%, short of a major disaster — “catastrophic” changes in the economy, spread out over several decades, or a once-in-a-century shift in investor behavior, to name two examples.

In other words, tune out the short-term noise ... and stay the course on stocks....

There’s one other eat-your-vegetables moral of the story in the report: . . .you can’t get to that long-term average of about 6% stock returns without the slow and steady churn of dividends. Sure, it’s not sexy, but the study shows that over the past 50 years, dividends and share buybacks provide 3.1% of the average annual return, compared to a 2.7% gain attributable to share price gains."Summing UpThe 5% to 7% long term annual returns predicted by McKinsey are inflation adjusted real returns. Thus, that's about 8% to 10% annually in nominal returns in a 3% inflationary environment. Dividend paying and dividend growing companies are the way to invest for the long run. As the U.S. conomy grows, company earnings, dividends and stock prices will grow as well. We will lead the world out of this period of economic stagnation.So stock ownership for U.S. investors is a good thing, and especially so in a low interest rate environment like today's and what will likely be tomorrow's as well.But even if the 'inflationistas' are right and inflation takes off down the road, which I don't believe it will, increased prices, earnings and dividends will still represent the best offset to inflation and a much better one than interest paid on outstanding bonds. In an inflationary environment, owning bonds is painful.Thus, with blue chip dividend paying stocks, it's heads we win and tails we win.At least that's still very much my take on things.Thanks. Bob.